In what could lead to significant tax implications, the finance ministry last month issued draft guiding principles for the determination of Place of Effective Management (PoEM) of a company. The government amended Sec 6 of the Income-Tax Act to introduce PoEM as the test to determine the place of residence of companies in the country. The change was included in the Finance Act, 2015, which received the President’s assent on May 12, 2015, and will come into effect from April 1, 2016.
Under the amended law, a company shall be considered resident in India in any previous year, if it is an Indian company, or its PoEM in that year is in India. PoEM has been defined to mean a place where key management and commercial decisions that are necessary for the conduct of the business of an entity, as a whole, are in substance made.
Prior to it, a company was considered a domestic resident in any previous year if it was an Indian company or if control and management of its affairs were situated wholly in the country during the year. The loophole allowed companies to avoid paying tax by artificially escaping residential status by shifting insignificant or isolated events related with control and management outside India.
Tax experts are divided on PoEM. Some feel it will plug the loopholes in the tax regime; other terms it as a ‘retrograde step’ by the government.
Welcoming the draft guidelines, taxation lawyer Tarun Gulati, partner, PDS Legal, said these provide directional guidance on many controversial issues. “PoEM is an attempt to plug the loopholes caused by the incorporation of shell companies outside India, even though effective management of such companies was from India. This shift has been proposed to bring companies that are incorporated outside India but being effectively managed in India under the Indian tax net, and to bring India’s test of corporate residence for tax purposes in line with international standards,” Gulati said.
“The government through the implementation of these guidelines seeks increased revenue by bringing into the tax net the companies which were shifting their taxable income outside India by incorporating shell companies outside the country. This is an attempt to reduce tax avoidance and evasion arising from selecting preferential residential status,” he elaborated.
According to the lawyer, these guidelines recognise that a company may have more than one place of management, but have only place of effective management at any given point of time. So, the guidelines give importance to substance over form. He further added that the companies primarily affected by the new regime will be the foreign companies having Indian branches and foreign subsidiaries of Indian holding companies.
The place where management decisions are taken would be more important than the place where such decisions are implemented and “substance” would be conclusive rather than “form”, tax experts feel.
According to them, non-resident firms outsourcing important functions to India that contribute substantially to their global value and domestic companies setting up subsidiaries abroad could now face tighter scrutiny on whether they were being effectively managed from India.
Says MS Syali, senior advocate specialising in tax litigation, “the new provision is a retrograde step in the stated object of promoting globalisation.” On one hand, the government is “promoting globalisation/ease of business for outgoing and incoming investments. On the other, it wants to tax the income of related companies even where the holding company in India takes policy decisions on the conduct of business,” the tax expert said, adding, “It is a reversal of the earlier statutory position without valid and cogent grounds. It is irrational and violates the doctrine of proportionality. The malady sought to be remedied was trivial in scope and deserved an appropriate amendment only.”
Experts have also raised concerns that guidelines will lead to double taxation for companies.
Says SC lawyer DL Chidananda, who has handled many tax matters including the Vodafone tax case, “many Indian companies with PoEM in India have set up companies in foreign shores. They are likely to be impacted. These regulations, read with amendments made to Sec 2 and Sec 9 of the Income-Tax Act by the Finance Act, 2012, may result in double taxation and lead to global tax cost.”
According to him, these companies will end up paying taxes twice on the overseas business—in the country where they earn income and now also in India on their global income.
“PoEM regulations are unilateral guidelines by India; these are not part of negotiations between countries with which India has entered into double taxation avoidance treaties. The foreign country may not recognise our understanding of PoEM,” he adds.
The guidelines will have significant implications since Indian companies will have to change the way they operate.
Analysts feel companies must have proper documentary evidence to prove that a foreign company’s management is actually situated outside the country. “Now, foreign companies will have to file their regular income-tax returns in India and obtain PAN here. Since their global incomes will be taxable in India, they will have to pay advance tax, self-assessment tax and maintain regular books of accounts,” Chidananda added. But he is of the opinion that the government should enforce these rules from the next financial year rather than April 1, 2016, to ensure that all the parties involved—revenue authorities, foreign companies and domestic firms—understand the new compliance regime.
indu.bhan@expressindia.com
